Oil Exporters Must Shift Capital Stock

As the Financial Times pointed out recently, oil companies such as Exxon Mobil and Shell would, under measures considered for the global climate pact to be sealed in Paris next year, cease to exist in their current forms in 35 years. The proposal of phasing out global carbon dioxide emissions as early as 2050 was not resolved in the UN climate talks in Lima last December. However, the adoption of even a watered-down version in Paris or in later rounds of climate negotiations would mean that the amount of oil and gas produced by these companies, and the quantity of coal mined by enterprises such as Rio Tinto, would need to be greatly reduced by mid-century. Such long-term concerns might over the next years trump current worries about an oil price slump that could be on the wane as soon as marginal projects and producers are shaken out from the bottom of the market.

Whereas Exxon and Shell are private companies, national oil companies such as Saudi Aramco, Statoil, and others control about three quarters of all crude oil production and more than ninety percent of reserves. Therefore, for a radical reduction in global carbon emissions to be achievable, state-owned oil companies will also need to strongly reduce the production of hydrocarbons. With corporations reducing production simultaneously, and paying less royalties, government revenue from hydrocarbons will be a fraction of what it is today. Compounding the challenges, oil-rich countries have become so dependent on oil export that a viable economic future would seem hard to imagine without it.

However, many current oil and gas exporters are doubly blessed, and exhibit exceptionally good conditions for the generation of renewable energy: high intensities of sunlight or wind, an abundance of unused land area available for the construction of solar plants and wind farms, and relative proximity to major energy markets. These conditions provide them with the option of remaining energy exporters even as oil output falls. Consider Saudi Arabia and other oil-exporting desert nations. The vast deserts of the Arab peninsula could accommodate enough solar plants to supply the entire European continent with power, while leaving capacity to spare for other neighboring regions. As a matter of fact, Saudi Arabia has already embarked on an ambitious program of renewable energy production for domestic consumption, aiming to generate 54 GW of renewable power by 2032, mostly from solar. To export solar energy from the Arab peninsula, large investments in transmission infrastructure would be required, and the intermittency problems associated with solar energy generation would need to be resolved. Other oil and gas exporters are blessed with windswept coastlines where energy can be captured from wind, waves and ocean currents.

The idea of exporting solar power to major markets from neighboring desert regions is not new. Morocco is fast developing its solar energy potential, in the first instance for domestic consumption, to reduce a reliance on fossil fuel imports that has strained its balance of payments. At the next stage, there are ambitions of exporting power to Europe. But, contrary to oil importers such as Morocco, oil exporting nations have been able to use proceeds from oil sales to build up very large capital reserves in the form of foreign assets held in sovereign wealth funds. The largest fund, Norway’s Government Pension Fund Global, holds $893 worth of foreign assets. The funds of the Emirates and Saudi Arabia are not far behind, with assets worth $773 and $757 billion respectively, and other hydrocarbon exporters have their own large funds.

The oil funds were set up to save for future generations, to stabilize the home economy in the face of highly volatile oil and gas prices, and to reduce the risk of large oil revenues generating asset bubbles and exchange rate appreciation. For that reason, oil funds’ investments tend to be fully or mainly concentrated in foreign assets, mainly traded securities. However, the rationale for oil funds could arguably change fundamentally as a result of their home countries’ decisions to shift fixed capital from offshore platforms, pipelines and refineries to solar plants and wind farms.

Firstly, objectives of preserving capital and earning a competitive return on renewable energy investments will become increasingly achievable as solar and wind technology continues to improve and more penalty measures are imposed on carbon emissions, through carbon taxing and regulation. Secondly, many of the components of wind and solar power infrastructure are typical import goods, which would limit the upward pressure on the exchange rate, or “Dutch disease”, frequently associated with domestic spending of revenues from commodity exports. “Dutch disease” and asset bubbles are generated by excessive spending on goods and services that are not internationally traded, such as construction work and locally produced construction materials. Imports, on the other hand, do not generate domestic price pressures because supply is in most cases highly elastic and prices are determined by global demand. The macroeconomic risk of investing in renewable energy at home could hence be manageable, and countries would need to find a balance between the use of imports and the option of developing national manufacturing industries to produce components for the renewables sector.

Finally, governments are increasingly seeing sovereign funds as a combined vehicle for optimization of returns and strategic national investments through equity and project finance. As for the state oil companies, several are already operating in the renewable energy sector, and their technical and managerial skills could be critical for a successful shift away from hydrocarbons. In Saudi Arabia, Saudi Aramco has been tasked with leading the implementation of the Kingdom’s renewable energy policy. In the long run, oil-rich nations could find that investment in their own capacity to remain energy exporters in a low-carbon world should be their highest strategic priority.


One Response to "Oil Exporters Must Shift Capital Stock"

  1. TheRadicalBaron   January 10, 2015 at 5:42 pm

    Excellent post about the energy transition from hydrocarbon to renewable. Undoubtedly the destination is clear but it has to be path is not a straight line but a gradual transition where the government should play a central role through fiscal policy. The SWF and NOC's could play an instrumental role by re-investing into the renewables such as bio-diesels, solar, eolic and tidal perhaps through 3P structures. The Capital markets could play a role by offering the funding through different structures including, debt, private equity, derivatives and the public listing of the companies in the sector. There is no silver bullet and as mentioned to some ultra-green advocates unless the public is ready to pay USD$6 Gallon at the pump USD$3 per loaf of breath the use of corn ethanol is not an option. That being said this turn down and manipulation from the middle east cartels is a reminder that energy independence is not a partisan issue but a strategic national and regional one where government and private sector need to collaborate. Brazil is far from perfect but their strategic policy to diversify from the O&G has already paid up in their ability to create cheap and reliable sources of sugar cane ethanol to supplement their crude production. Clearly the NAFTA partnership could develop a similar initiative where the energy mix for the portfolio can become a reality, the lower 30 states in the US are within the sweet spot for solar energy production, Mexico has a great deal of arable land and the US shore lines can provide a great amount algea based bio-diesel. At the same time the collective consumption of corn and canola oil across the NAFTA can facilitate the creation of small producers in the recycling and creating of bio-diesel. The technology is here and is only a matter of conviction NAFTA has everything to become energy independent and a net exporter of energy and technology. Perhaps we need a real leader beyond politics someone like Elon Musk he is proven that America can lead from the front we need to clone this guy and get rid of the no can't do from our vocabulary. God bless America and the hard working people around the NAFTA.